Islamic Financial Accounting Standards to Ijarah by Ahmed Al

Scope of PresentationThe scope of this presentation comprises of the following; - Definition and Salient feature of Ijarah - Application of the Standard - Major difference Between Accou

Islamic Financial Accounting

Standard-2 IJARAH

Interpretation and Implementation

Ahmed Ali Siddiqui

Vice President & Manager Product Development & Shariah

Compliance

Scope of Presentation

The scope of this presentation comprises of the following;

- Definition and Salient feature of Ijarah

- Application of the Standard

- Major difference Between Accounting of Finance Lease and Ijarah (Operating Lease)

- Accounting Policies and Recording Procedures of Ijarah transaction as per the requirements and guidelines of IFAS-2

- Accounting Policies for Ijarah

- Recording procedure and disclosure requirements of Ijarah

transaction as per IFAS-2

- Points for discussion

Concept of Ijarah

• Ijarah is an Islamic alternative of Leasing.

• Leasing backed by an acceptable contract is an acceptable transaction under Shariah

“Ijarah is a contract whereby the owner of an asset, other than consumable, transfers its usufruct to another person for an agreed period

at an agreed consideration.”

Definition and salient Feature of Ijarah

Salient Feature of Ijarah

 Contrary to Finance Lease, in Ijarah the ownership of the assets remains with Lessor (the bank) and only its right of

usage is transferred to the lessee.

 Until the assets to be leased are delivered to the lessee, no lease rental become due and payable (i.e Ijarah cannot be recorded until the subjected asset is delivered to the lessee.)

 The title of the assets remains with the Lessor during the entire lease term.

 The Lessor bears all the risk and reward associated with the ownership to the asset.

 All cost associated with the asset to bring it into usable form and condition should be borne by the lessor.

Types/Classification of Ijarah

1 Operating Ijarah

Operating Ijarah is a lease that does not include

a promise that the legal title in the leased asset will pass to the lessee at the end of the lease

2 Ijarah Muntahia Bittamleek (Ijarah wa Iqtina)

It is a lease that concludes with the legal title in the asset passing to the lessee after Ijarah Ijarah Muntahia Bittamleek includes:

 Ijarah through gift

 Ijarah & transfer of legal title at the end of the lease for a

token consideration or other amount as specified in the lease

 Ijarah through transfer of title prior to the end of lease at a

price pre-decided

Types/Classification of Ijarah

3 Ijarah tul Musha or Joint ownership Ijarah

It is a lease where Bank & customer jointly owned the leased asset Bank gives its share to the customer on lease

After the term of Ijarah, the treatment is similar to Ijarah Muntahia Bittamleek

Types/Classification of Ijarah

Process of Ijarah(Muntahia Bittamleek)

CUSTOMER ISLAMIC BANK

request for Ijarah financing and enters into a promise to lease agreement

 The Bank purchases the item required for

leasing and receives title of ownership from the vendor

VENDOR

.

Agreement-1

Process of Ijarah

CUSTOMER ISLAMIC BANK

 The Bank leases the asset to the customer after execution of lease agreement

Accounting Standard for Ijarah

IFAS 2 - Ijarah

Application of Standard

The Islamic Financial Accounting Standard (IFAS)-2 “ IJARAH” was issued

by the Institute of Chartered Accountants of Pakistan and was adopted by the Securities and Exchange Commission of Pakistan vide its notification S.R.O

431 (i)/2007 dated May 22,2007.

Effective date

IFAS-2 becomes operative for financial statements covering periods beginning

on or after July 01, 2007

Retrospective application of this IFAS is not mandatory i.e the IFAS is

applicable for Ijarah commencing on or after July 01, 2007.

Accounting Policy for Ijarah

Ijarah Asset Recognition

• All Ijarah transactions are to be recorded as “Asset Acquired for Ijarah” at sum of all Cost incurred by the bank in acquiring the asset

• Assets are to be stated at their cost less accumulated

depreciation and impairment if any

• Depreciation is to be charged to income applying the method which reflects the pattern in which the asset’s future economic

benefits are expected to be consumed by the bank

• In respect of addition and disposal of assets, depreciation will

be charged from the month of acquisition till the month of

disposal

Accounting Policy for Ijarah

Case Study for Ijarah

Below is the case study for the understanding of

suggested Ijarah accounting:

Recording Procedures and Disclosure

requirements

Following are the scheme of accounting entries to be recorded in the book of

Lessor (the bank)

Jan 1, 2007

1) At the time of payment to the client for the purchase of asset on behalf of

bank or directly to the supplier by the bank ;

Feb 1, 2007

2) When the asset is deliver to the lessee

Recording Procedures and Disclosure

Disclosure in Balance Sheet at month end (Feb 28,07)

Less:

5) At the time of receiving of Rental following entry would be passed:

6) At the time of maturity of Ijarah Contract

Recording Procedures and Disclosure

requirements-continued

7) In case of default in payment of rental

(with the amount of rental receivable previously accrued and taken to

income)

8) Provision for Impairment of Ijarah assets

Recording Procedures and Disclosure

requirements-continued

Disclosure in Balance Sheet at period end

Less:

Rental Receivable

Less:

Recording Procedures and Disclosure requirements-continued

Common Questions Raised

Sheet (Under the classification of financing)

 Does Ijarah will be consider for ADR

 What will be the guidelines for provision for doubtful debt and Income suspense in case Ijarah is consider as financing under

prudential regulations for banks

 In case Ijarah does not fall under the definition of financing, what will be the guidelines for general provisions for consumer finance

THANK YOU